Monday, September 24th, 2012

Global Equity Models Commentary 24/09/2012

(This commentary was written originally specifically for the Sterling Global Equity Model)

Market conditions

When central banks in the US and Europe become active, sterling can get caught in the cross currents, and unhedged equity portfolios run the risk of misinterpreting the signals. Most of the time, we think that currency hedging for equity portfolios is expensive and irrelevant, but there are occasions, such as now, when we would be tempted to do so. The outlook for Eurozone equities really has improved as a result of the ECB action, but the strength of the euro has exaggerated the effect in sterling terms. The outlook for the US has not deteriorated, even though the currency has fallen because of the impact of QE3. Our diagnostic tools (e.g. the probability curve) suggest that there is less conviction than normal behind the calls relating to these regions.

Current portfolio

The biggest gainer in terms of portfolio weight is Eurozone equities, which has seen a very significant increase over the last four weeks, almost certainly too much, too soon. We are happy with the direction of travel because we think that the region was oversold in Q2, but if we were allowed to second guess the model we would either have a lower exposure, or we would hedge some of the downside. The weights of US and UK equities are largely unchanged over the last two weeks, and the obvious implication of the previous sentence is that they should have gone up. The big decline has come in UK bonds, where yields are so low that they are bound to suffer as soon as there is no compelling reason to sell risk assets.

Outlook

We stick with our view that risk-assets will climb a wall of worry over the autumn, even though the volatility in currency markets may mean that, for sterling investors, it is sometimes difficult to work out which wall. In the comments on our US$ multi-asset model we argue that there is room for a positive surprise from emerging markets. This is particularly true in sterling terms, because the recent improvement in return per unit of risk from emerging markets has been disguised by the weakness of the US dollar. Strange to tell, the total returns from emerging markets in sterling terms are less volatile than those of UK equities. It would only take a small improvement in momentum to generate a significant increase in the recommended weight of emerging markets.

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